Why Higher U.S. Savings Won’t Save the Pandemic-Hit Economy

U.S. households will likely respond to the shocks of the pandemic by increasing their savings rates, as will foreign households. If the U.S. government does not decisively increase spending, higher American household savings will force either American debt or unemployment to rise even more.

According to a May 2020 CNN article, one consequence of the coronavirus pandemic is that “Americans are slashing their spending, hoarding cash and shrinking their credit card debt as they fear their jobs could disappear.” The article goes on to say that U.S. credit card debt has fallen by the largest percentage in thirty years while household savings rates have climbed to levels unseen since the 1980s.

While part of this increase in savings may be a temporary reaction to the lockdown, and consumer spending could very well pick up again quickly once conditions return to normal, there are many reasons to believe and some evidence to suggest that American households will cut back permanently on at least some future discretionary spending to have a higher savings buffer in case of future crises.

The idea that Americans want to consume less and save more might seem at first like a good thing, but it could put a severe damper on the consumer-driven U.S. economy as a whole: after all, one person’s spending is another person’s income. So even if individual Americans strive to save more money, that may not be enough to drive up the collective American savings rate, which can only rise under very specific—and improbable—conditions. Put differently, if some American households decide to save more, the country’s overall savings rate will not rise unless some other (unlikely) adjustments or tradeoffs elsewhere in the economy allow that to happen.

What’s more, higher household savings isn’t always a good thing for the broader economy. It could be positive or negative for the United States depending on what the country’s pandemic-era economic adjustment looks like. Because total U.S. investment is by definition equal to total American savings (that is, the savings of households, businesses and the government) plus net foreign savings (that is, the current account deficit), at the macro level there are only three ways the adjustment can play out. A higher household savings rate could be accommodated by a decline in the American current account deficit, or it could result in an increase in U.S. investment, or it could be matched by negative saving elsewhere, so that the total savings rate would not rise. There is no other way the economy can absorb a rise in the savings rate of American households.

It is important to understand the limited ways the economy can adapt to higher U.S. savings rates when grappling with the policy options.

Will Higher U.S. Household Savings Trim the U.S. Current Account Deficit?

In most other countries, a boost in household savings would almost certainly cut the current account deficit, but the United States is different. Countries that run current account surpluses must save more than they invest, and countries that run current account deficits must save less than they invest. The fact that the United States runs a current account deficit, in other words, means that U.S. savings is less than U.S. investment. Many mainstream economists would therefore conclude that any increase in U.S. household savings, by reducing the gap between investment and savings, would reduce the U.S. current account deficit.

But they are forgetting something. As the world’s borrower of last resort—the automatic recipient of the world’s excess savings—the United States operates differently than most countries. Because its deep, well-governed financial markets and its highly credible currency work automatically to absorb excess global savings from abroad, the United States is one of the few countries in the world that has no control over its domestic savings rate. The United States runs a current account deficit not because it saves too little, in other words, but rather it saves too little because it runs a current account deficit, the automatic corollary to its capital account surplus.

This dynamic has very important consequences during the coronavirus pandemic because the problem of excess savings by other countries is poised to get even worse. It is not just U.S. households who will likely respond to the economic downturn by saving more. Foreign households will also save more, and because much of this excess savings will be exported to the United States, the U.S. current account deficit is likely to rise, not fall. This means that no matter how frugal U.S. households become, higher U.S. household savings will not reduce the U.S. current account deficit: on the contrary, the country might be forced to accommodate an even higher deficit.

Will Higher American Household Savings Boost Investment?

It may seem as though higher U.S. household savings could be a shortcut to greater U.S. investment and a boon to economic growth, but that isn’t necessarily true either. If the United States were a developing economy with high investment needs constrained by scarce and expensive capital, an increase in domestic household savings rates could certainly result in higher investment. But in developed economies like that of the United States, the main constraint on business investment is expected demand, not capital scarcity. So, if anything, belt tightening among U.S. consumers could be a drag on investment, not a boost. That is why if American households decide to save more and consume less, the most likely consequence—as occurred, for example, in Germany after the 2003–2005 labor reforms that reduced wage growth and increased German savings—would be reduced business investment.

If U.S. households do reduce consumption and businesses do reduce investment—the latter condition exacerbated perhaps by a higher current account deficit—the combined effect would create a drop in total domestic demand, which would force businesses to close and lay off workers. The only way to counter this would be for Washington or local governments to engage in public sector investment in infrastructure (or incentivize the private sector to do it). Higher American household savings can only cause investment—and with it total savings—to rise, in other words, if the government responds by spending substantially more on public sector infrastructure. The private sector by itself cannot do the job.

Will Higher American Household Savings Cut Into Savings Elsewhere?

If U.S. investment doesn’t rise and if the U.S. current account deficit does not contract, total U.S. savings cannot rise. What’s more, if the current account deficit expands and business investment declines—both scenarios that are possible and even likely—total American savings actually must decline to balance lower investment and a higher current account deficit.

This reality may seem very counterintuitive, so it is worth asking: how is it possible for total U.S. savings to remain unchanged or even decline if American households react to the pandemic by increasing their savings rate? There are basically four ways this can happen:

The drained savings of laid-off workers: Falling household consumption—perhaps exacerbated by a decline in business investment and a wider current account deficit—might cause American businesses to lay off workers. Unemployed workers produce nothing but must continue to consume, so they are forced to deplete their savings or the savings of others. This is why total U.S. household savings would be flat or even down, even though some American households will be saving a larger share of their income. The negative savings of unemployed Americans would cancel out the increased savings of Americans who were able to retain their jobs.

Ballooning consumer debt: The Federal Reserve and U.S. banks—the former concerned about rising unemployment and the latter forced to absorb higher savings—might respond by implementing policies to encourage some American households, usually those previously unable to borrow, to take on new credit card debt. The net result would be that their higher debt (debt is negative savings) would cancel out the higher savings of other American households. As in the above case, total U.S. household savings would again be flat or perhaps even decline, even though some American households would be saving a larger share of their income.

Boosting government spending: Washington and local governments could implement policies that create consumption on behalf of households by, for example, increasing healthcare benefits, paying for education, and otherwise strengthening the social safety net. By consuming (on behalf of households) government spending could balance out the lower household consumption caused by the pandemic. But even if that happens, higher household savings would be matched by lower government savings.

Redistributing income: Washington could implement policies that redistribute income from wealthier Americans, who save a higher portion of their income, to poorer Americans, who save a lower portion. If such policies are enacted, U.S. household savings wouldn’t rise because higher savings among poorer households would be matched by lower savings among wealthier households.

How Will the U.S. Economy Adjust?

Total U.S. investment is by definition equal to total American savings plus net foreign savings (that is, the current account deficit), which means that there are a very limited number of ways that the U.S. economy can respond to a rise in the household savings rate. These are listed below. Some scenarios are not entirely outside the realm of possibility but seem highly unlikely.

One possible scenario is that the U.S. current account deficit could contract, but that is very unlikely, and if the rest of the world also responds to the pandemic by saving more, it is more likely that an incoming deluge of excess foreign savings will force the U.S. current account deficit to expand even more.

Another possibility is that U.S. businesses could increase investment, but that seems like a longshot too. Because a higher household savings rate and a constant or bigger current account surplus would reduce aggregate demand, business investment is more likely to contract.

The Federal Reserve and American banks could try to reverse the higher household savings rate by encouraging consumer debt—usually among the poorest households—in which case rising consumer debt by some households would balance out the increase in savings by others. This approach would merely postpone, not resolve, the problem of weak demand, and it would increase the financial fragility of the U.S. economy.

Washington and local governments could strengthen the social safety net and increase consumption on behalf of U.S. households.

Washington and local governments could also implement policies that significantly increase much-needed infrastructure investment.

Finally, if business investment doesn’t rise, the current account deficit doesn’t decline, and government spending on infrastructure or the country’s social safety net doesn’t markedly increase, any increase in savings among some American households must result in a reduction in savings in other American households. If this balancing out isn’t caused by increasing consumer debt, it must be driven by rising unemployment.

A few other technically possible but very unlikely responses can safely be ruled out. The U.S. government is highly unlikely, for example, to allocate massive amounts of foreign aid to developing countries (thus lowering the U.S. current account deficit) in the current economic and political climate. Americans could use their savings to go on a house-buying spree, but that doesn’t seem likely either. Otherwise, the aforementioned options are the only ways the United States can adjust to higher household savings rates.

Economically speaking, the best options would be for the government to pursue efforts to build and repair American infrastructure, redistribute wealth downward, and/or strengthen the country’s social safety net. Next best would be to reduce the current account deficit by intervening to keep foreigners from dumping their excess savings in the United States. The worst options would be to reverse higher household savings by encouraging consumers to embark on a credit-fueled spending spree, and, of course, to allow unemployment to rise. Unfortunately, the country has no other practical options.

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CR

May 21, 20201:26 pm

Other countries will reduce savings. They have less cushion, on individual levels, than do US citizens. Take italy for example, starvation may be imminent as tourism dependent jobs were a large part of employment. 35%? Borrowing will increase as will debt (defacto not dejure) writeoffs.

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Michael Pettis

May 28, 20202:00 am

Reducing savings is not the same thing as reducing the savings rate. If income drops, a higher savings rates may be consistent with lower total savings, but that only makes the problem described in this essay worse, not better. The key is how demand is affected.

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mark

May 22, 20209:49 pm

the usual well argued and logical exposition to which i will add: Or, as in the 1930s, we end up with some mix of de facto/de jure trade and capital controls around continental production zones (rather than the 1930s formal imperial blocs) as states try desperately to limit unemployment and its associated fiscal stresses, and limit other countries'/blocs efforts to export their unemployment. but this, as i imagine you and klein argue in the new book, is a function of specific domestic political conflicts.

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Michael Pettis

May 28, 20202:02 am

I agree that this eventually ends with capital controls. There is no reason -- except to benefit banks -- why even large economies like that of the US, let alone smaller ones like Switzerland, should be distorted by massive capital movements.

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Larry Peterson

May 22, 20205:52 pm

Great piece, Michael, as usual; given the alarming breakdown in international relations, is it even possible to envision a coherent international response to the effects of the sort of seemingly intractable imbalances you have so well mapped out, especially with COVID and climate change (not to mention the usual negative externalities) set to overwhelm the developing world? If not, where do you see the next dangerous distortions developing? And, even if there is a temporary fix, whom does that end up disadvantaging: in your appealing outline, developed country (especially US, but also German, even Chinese) working class interests seem at a complete standoff with elites resisting income distribution. And, one last thing, if you would be so kind: where will tax havens and intellectual property laundering end up here? Sorry for the long set of questions, thank you so much for your great work over the years

Great post as usual. I looked up Federal Reserve foreign currency liquidity swap arrangements with foreign central banks wondering how they might influence the US current account and whether or not they might add to the US deficit and potentially cause US household savings to fall or unemployment to rise. The amounts are quite large around 791,000,000,000 for terms of between 7 and 90 days. I checked the spread sheet again and it gives that total. 791 billion really is a very big number. And I guess it that number were to stay high for a quarter or two it would have a material impact. Perhaps swaps don't impact the current account but it seems to me they should. If they do then its another example of the FED along with the rest of the US financial system is prioritising the welfare of the wealthy members of the rest of the world along with the US banks and their wealthy customers over the welfare of the average US household.

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Ez.

May 23, 202011:29 am

One notable concept that does not appear in the piece: inflation.
It would be interesting to get your thoughts on how inflation may factor into the analysis and impact the different potential outcomes. As just one example: how does the governments policies of buying trillions of financial assets (mostly loans) impact inflation generally, and/or pockets of inflation in financial assets. Surely the magnitude of the financial purchases will interact in a number of complex ways with the real data you discuss; investment, savings, GDP growth, etc.
Thank you for your continued insightful analysis and congratulations on the release of your new book.

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Michael Pettis

May 28, 20202:06 am

Much monetary expansion is leading to asset price inflation, and not the kind of inflation we usually mean, but for me inflation is a kind of tax, and its impact depends on the direction of the effective transfers.

Michael, thanks for a great piece. One issue: Is it really *highly unlikely* that "Americans could use their savings to go on a house-buying spree"... I'd argue the contrary, that it is a very strong possibility:
1. US Demographics mean that Millennials are starting families so there is a huge wave of demand for US housing ownership;
2. The 2005-6 housing over-build has been absorbed, so there is limited supply, especially at entry-level;
3. Interest Rates (Mortgages) should remain very low, favoring buy over rent;
4. Baby Boomer parent savings could be used for Millennial down-payments (how else will the Baby Boomers actually get any grandchildren?!),
5. The Pandemic experience gives extra incentive to own a home (It sucks to live with your parents or to rent from a mean-spirited landlord, and home owners seem better-protected politically from foreclosure).
Seems to me like the US is ripe for a sustained household formation, home-building and home-purchasing boom, with all the associated consumption that creates. What am I missing?

I wonder how infrastructure/redistribution/safety net can be the best economic options when none of those options are subject to market discipline. Now, restricting capital inflows sounds like another affront to the market, but it symmetrizes an otherwise asymmetric (and unsustainable) dynamic. I think this is the best option. Infrastructure, notwithstanding the inherent inefficiency of most such activity, is second best--it's a necessary evil. Rendering it more robust, more decentralized, to include plenty of distributed solar and SMRs, would be a worthwhile goal that matches up economic and national security priorities. Another job creating project is the repatriation of manufacturing, which will be more rapid if goosed with Federal funding. This happens to also be a national security project. This type of national industrial plan is practical, especially when paired with capital controls. Of course, it violates in a pedantic sense market discipline, but this temporary and is only necessary due to the loss of manufacturing during the system of dollar hegemony and trade deficits.
I'm inclined to think that the worst option is further expansion of the social safety net, in large part because such expansions are always irreversible. Government programs, and particularly handout programs, never ever end. Let us not intensify our demosclerosis due to passing difficulties. The currently available programs will be utilized by far more people during the economic contraction, providing a time-limited boost. I would not oppose another national dividend like the $1200 recently printed, even if it were substantially more generous. But, I oppose any new handout constituencies to bribe the public and further distort the political system.

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perlo

May 24, 20205:59 pm

Great piece, I've learned a lot from your writing thank you.
You've written in the past something along the lines that productive investment is productive because it "pays for itself". What does that mean exactly? Does it mean the government collects higher taxes in the future? Does it mean long-term GDP increases? Or something more qualitative like welfare is improved that might be more difficult to measure. In other words does "pays for itself" rely on accounting or a qualitative discussion of costs vs benefits? Spending on end of life care might be one example that highlights the difference. Or technology that decreases GDP.

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Michael Pettis

May 28, 20202:11 am

It pays for itself if it boosts the value of the economy (for which GDP is often a proxy) by more than the amount of the debt. In that case the additional demand created by the spending is matched by the additional supply, so that there is no inflation.

Would it make it more likely China may be forced strategically to begin move away from its export model to a higher share on consumption, given the low marginal returns on investments? Huge near-term pain but longer term benefits?

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Paul

May 30, 202011:55 pm

Given the state of Sino-US relations and strategically speaking, do you think it possible that China will bite the bullet and move away from its export model to a more domestic-driven economy i.e. a greater share of consumption and less financial repression transfers (adding to near-term pain for the banks)?

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